LBS says tax rises will slow recovery

THE TAX increases announced in last year's Budgets will slow economic recovery, but interest rates are unlikely to drop by more than another quarter point before they have to be raised to restrain inflation, according to a leading economic forecasting group.

The London Business School says it agrees with the Treasury's forecast of 2.5 per cent growth in national output this year, but predicts that growth will then drop to 2.2 per cent in 1995 before accelerating only gradually.

In its latest 'Economic Outlook', the LBS says high-street spending and domestic demand have been depressed on each of the three occasions since the 1960s when comparable tax increases have been implemented. 'There is clearly a risk . . . that tax increases will stall the economic recovery.'

The LBS says base rates are likely to drop to 5 per cent during the spring, as the tax increases raise fears for the recovery. But later in the year the debate will turn to when base rates are likely to rise.

Interest rate and exchange rate policy is already stimulating the economy, with a significant part of the effect still to feed through. The LBS says underlying inflation could rise by a further one or two percentage points if interest rates are left at current levels. This would make it difficult for the Government to meet its target of 1-2.5 per cent underlying inflation by the end of the parliament.

Unemployment is forecast to fall below 2.6 million by early 1995 and below 2.4 million in 1997. The trade deficit is expected to widen slightly while public borrowing should fall quickly enough to allow tax cuts before the election.